“Particularly worrisome” is that this slowdown “has taken place in a context where the US economy is growing above potential.”

The bad omens are stacking up for Mexico’s faltering economy as both domestic consumption and investment dry up while the challenges facing the country’s heavily indebted state-owned oil giant, Pemex, continue to rise. That’s the broad conclusion in the minutes of the latest meeting of the Bank of Mexico’s governing board.

Mexico’s benchmark index, the BMV IPC, has fallen 15% in the last year. For the first time since December 2018, the Mexican peso is once again below the all-important psychological level of USD$0.05 (or 20.07 pesos to $1), after having fallen by 6% in the last month, due in part to the emerging market jitters set off by Argentina’s latest woes, which resulted in yet another selective default on its debt that markets expect to expand to a full default on its foreign-currency debt.

Then, of course, there’s Pemex, whose $100 billion of debt is perilously close to receiving a downgrade from investment-grade to junk from the second ratings agency. If that happens, the state-owned company would become the largest “fallen angel” in history, which will probably lead to the forced selling of more than $10 billion of its bonds as well as a possible downgrade of Mexico’s sovereign debt.

As if all that wasn’t enough, the economy has stopped growing, having registered a barely perceptible 0.1% second-quarter rise in real GDP, after shrinking 0.3% in the first quarter. Following in the footsteps of U.S. rating agencies, the IMF and a clutch of domestic and international banks, the Bank of Mexico — Banxico for short — sharply revised downward its 2019 GDP forecast for Mexico, from a range of 0.8%-1.8% to 0.2%-0.7%. It was the fifth time this year it had slashed its growth forecast.

Some board members described the recent slowdown as “greater than anticipated”. While global economic pressures are partly to blame — in particular the risks posed by the China-U.S. trade war, Brexit, a slowing European economy, and continued failure to ratify the United States-Mexico-Canada Agreement (USMCA) — what is “particularly worrisome”, said one board member, is the fact that this slowdown “has taken place in a context where the US economy (Mexico’s biggest trading partner) is growing above potential.”

Mexican exports continue to perform fairly strongly. But domestic consumption and investment are both sliding. According to central bank data, consumption growth has been declining for years, from 4.3% in 2016, to 3.1% in 2017 and 2.3% in 2018, but the trend appears to be intensifying. At last count, in May 2019, the annualized rate of growth was 0%. The consumption growth of durable goods is already in negative territory for this year, pointed out one board member, despite robust growth in both remittances — transfers of money by workers of Mexican descent mostly in the US but also other countries to individuals in Mexico — and wages.

Private investment, particularly in construction and in the purchase of imported machinery and equipment, is falling sharply. With seasonally adjusted data, investment in construction is at levels unseen since early 2006, when records began, noted one member. As we reported last month, there are two main reasons for this drop-off:

One, many private sector investors are afraid to invest. Since Mexico’s new government came into power in December, there has been much greater enforcement of laws and regulations concerning construction, which has made life more difficult for companies in the sector.

Two, public sector projects have ground to a virtual standstill. Mexico saw a a 24% year-on-year drop in public sector projects in May, compared to a much milder 1.2% fall for private sector works. This slowdown in public sector construction has been particularly pronounced in the capital, Mexico City, where almost 500 public and private development projects — over 40% of all the projects under way — have been halted or cancelled by the new city council.

Less than a quarter of private sector analysts surveyed by Banco de México consider the current economic panorama to be favorable for investment, with many blaming the downturn on a combination of domestic economic conditions and what the central bank calls “governance problems,” including public insecurity, the absence of rule of law and political uncertainty.

Some Banxico board members cautioned about the weakness of investor sentiment in Mexico, with one highlighting impacts from the government’s cancellation of a partly built airport for Mexico City, the suspension of private partnerships for Pemex, and a dispute with natural gas pipeline firms.

These criticisms risk aggravating already fraught relations between the country’s government and central bank.

And right now, with the country arguably facing its biggest economic challenge in a decade, smooth relations between the two are vital. Mirroring developments north of the border, the government has been pressuring the central bank to slash the benchmark interest rate, currently at 8%, to encourage consumption and private investment.

In mid-August, Banxico obliged, albeit timidly, reducing the benchmark rate by 25 basis points. For now there’s little sign of further rate cuts, especially given the bank’s deputy chairman, Javier Eduardo Guzmán-Calafell, strongly opposed the previous rate cut on grounds that it could reignite headline inflation, which, at 3.75%, is currently at its lowest point since late 2017. Less than a year ago, it was close to 7%.

But Mexico’s high interest rates, needed to tame inflation, have also attracted a massive inflow of “carry trade” hot money. This hot money is one of the main reasons why the peso has remained fairly stable in recent months despite all the problems. Slashing interest rates now could risk triggering a rapid reversal of those hot money flows, which in turn could hammer the peso further, precisely at a time when emerging market fears are on the rise across the globe. By Nick Corbishley, for WOLF STREET.

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